The personal blog of Peter Lee a.k.a. "China Hand"... Life is a comedy to those who think, a tragedy to those who feel, and an open book to those who read. You are welcome to contact China Matters at the address chinamatters --a-- prlee.org or follow me on twitter @chinahand.

Monday, October 10, 2011

Tires, Trade, and Virtual Nobel Prizes

Criticism of Senator Schumer’s legislation to punish China for currency manipulation often points out that the most likely outcome of any sanctions would be to shift manufacturing from China to some other low-cost Asia locale, not bring it back to the United States.

Paul Krugman, on the other hand, believes that the US will discover proper exchange rates and suitable areas of competitive advantage vis a vis its trading partners, if and when currencies get a chance to sort themselves out correctly. Sanctioning China’s currency manipulation, in his view, would be an important and positive step toward that goal.

I hesitate to argue with Paul Krugman and his Nobel Prize…actually the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (Nobel had no desire to give honor practitioners of the dismal science; the Swedish state bank gave itself a feel-good present on its 300th anniversary by endowing the prize in 1968 and the Nobel foundation obligingly went along. I suppose that the Ikea Prize in Ready-to-Assemble Furniture in Memory of Alfred Nobel can’t be far behind)…

Anyway, foreign currency trade is immense and can quickly change the international economic landscape, at least on the current account.

However, I think the emphasis on nation-to-nation competition is misplaced when it comes to the capital account and corralling investment in nice new factories.

The dynamic that drives international investment today seems to be nations in a losing struggle to pursue national advantage while global corporations succeed in pursuing global corporate advantage.

Corporations love profit. But they love growth in profits even better. And America is not delivering the growth.

When the US slaps China around, China loses. American corporations gain. But not in the way one might expect. They gain by adjusting production within their global portfolio of factories with an eye to optimizing growth opportunities.

Instead of looking for merely adequate advantages in the country of its birth, I believe, capital, as befits its globalized, fungible character, flows overseas seeking optimal returns.

I'm sure there are plenty of non-Nobelist as well as Nobelist economists who would be happy to set me straight on this matter.

When they do so, they can also address the issue of US protective tariffs targeting cheap Chinese tires.

Globalized tire companies, including those that are US-registered corporations, profited.

They didn’t profit by increasing US output. They profited by shifting supply to their other low-cost plants in Taiwan, South Korea, and elsewhere.

And they took those profits and reinvested them…in China. Because that’s where the growth is.

Here’s the article I wrote about the tire tariffs in Asia Times. You can click through to the AT archives to get the article and the links.

A World Trade Organization appeals court has ruled in favor of the Barack Obama administration on the issue of the tariff it slapped on imports of Chinese tires in 2009. With President Obama's acceptance of the recommendation of the US International Trade Commission, Chinese tires were assessed at an eye-popping tariff of 55% in 2009, declining to 45% on 2010 and 35% in 2011.

A certain amount of misinformation is apparently de rigueur in cases of this sort. No, for Tom Barkley of Marketwatch, the US levy was not a "punitive" tariff. [1] It was a protective tariff, one that acknowledged that the Chinese tires were cheaper, but that the influx was causing unacceptable hardship to American industry.

The Obama administration imposed the tariff under Section 421 of the Trade Act of 1974. Per the US China Business Council backgrounder, "the statute allows the United States to impose duties or quotas to counter 'market disruption' caused by rapidly increasing imports from China. Unlike other trade remedies under US law, the imports don't have to be proven to result from dumping or other illegal actions. [2]

As a price of acceding to the WTO, China agreed to accept imposition of national protectionist measures - aka a "Transitional Product-Specific Safeguard Mechanism" - if discussions failed to cope with a situation of increased Chinese imports that "cause[d] or threaten[ed] to cause market disruption to the domestic producers".

Market disruption shall exist whenever imports of an article, like or directly competitive with an article produced by the domestic industry, are increasing rapidly, either absolutely or relatively, so as to be a significant cause of material injury, or threat of material injury to the domestic industry. In determining if market disruption exists, the affected WTO Member shall consider objective factors, including the volume of imports, the effect of imports on prices for like or directly competitive articles, and the effect of such imports on the domestic industry producing like or directly competitive products. [3]

It would appear to be a fool's errand to challenge this ruling, giving the avalanche of Chinese tires that entered the US in 2006-2008 and the obvious implications for employment in the US tire industry.

According to the United Steel Workers Union, Chinese tire imports by volume grew 215% from 2004 until 2008, reaching a volume of 46 million tires. [4]

However, the Chinese case was not quite as weak as one might think.

The PRC's representatives argued that US manufacturers had made a strategic business decision to focus on the most demanding - and profitable - customers, who would not accept a no-name import: the auto manufacturers (known as OEMs or original equipment manufacturers) and the so-called "tier one" replacement customers, who paid more for brand-name, high performance tires.

As a result, the Chinese and other suppliers rushed into the "tier two" and "tier three", that is the cheap and cheaper unbranded market, to slug it out.

Perhaps more to the point, it appears the PRC was attempting to draw a pre-emptive line in the sand and establish some procedural and interpretive precedents to inhibit the serial imposition of protective tariffs in trade disputes.

The PRC asserted that the US procedures leading up the imposition of the penalties had been excessively subjective and slapdash and did not rise to the standard of evaluation demanded by section 16.4. The effort was an outright failure.

The appeals panel slapped down the Chinese, and received aid and comfort from friends of the court briefs filed in support of the US position by the European Union and Japan.

The ruling does not make for particularly inspiring reading. Especially at the appellate level, the "rule based" world order that the US professes to promote and, when convenient, adhere to, is largely a matter of legalistic wriggling.

The PRC asserted that the US had cherry-picked the data to focus on the year of biggest increase, 2008, and had failed to define what "rapid growth" actually was; the WTO ruled that there were no limits on subjective interpretation.

The WTO also ruled that "material" injury was a lower bar than "serious" injury and relieved the US of any obligation to make the case that a specific amount of injury had been caused by Chinese imports, as opposed to other factors such as strategic decisions by US suppliers, the global recession, or competitive pressures of other exporters.

For instance, since Chinese imports were cited as one of four factors in the shutdown of a Bridgestone plant in Oklahoma, that was taken to be evidence of "material" injury, albeit of an undefined degree, that justified the protective tariff.

Moving beyond the ruling, the end result of this protectionist posturing was not terribly impressive.

As free-trade advocates (and the Chinese) quickly pointed out, the result of the protective tariff was not to spur a significant increase in US employment in the tire sector.

Instead, the supply sourcing shifted from the PRC to Taiwan, South Korea, Japan, and Indonesia, all happy to divvy up the low-end market, presumably at higher prices now that the PRC, the most significant low-cost producer, was out of the picture.

In 2010, the US China Business Council issued a widely-publicized (at least in China) Issue Briefing that stated:

Comparing the first half of 2010 with the same period in 2009, total US tire imports affected by the 421 tariff are up 21% by volume and 30% by value. China's share of those imports has dropped from a peak of 45% in August 2009 to just 24% in June 2010. In other words, Americans are buying more tires from overseas - we're just getting the tires from places other than China. [5]

During the same period that the Chinese tires were shut out of the US market, the price of tires jumped over 10%.

Perhaps most students of international trade and foreign relations do not spend much time reflecting on the plight of the financially strapped US buyer of low-end tires - or the retailers that service them - but this October 2010 report from Barry Schlachter of McClatchy, provides some food for thought:

Overall, consumers are paying about 12% more for blackwalls than a year ago, said Bonnie Moreland of Texarkana, Texas-based Golden Star Tires, adding that the jump would be even higher if he didn't absorb some of the waves of price increases imposed by manufacturers.

Dealers who advertised specials like four ''economy'' tires for $99 three years ago are selling them today at $299 to $340 - if they can find the products, said George Salinas, co-owner of G&M Tires in Fort Worth, Texas.

The higher cost makes it harder to stock tires that are available.

''I used to carry 300 tires,'' Salinas said. ''Now I have less than 100 in stock because I can't afford to have them sitting on the shelf.''

Jim Smith, editor of Akron-based Tire Review magazine, which covers the retail industry, said: ''Dealers are terribly frustrated. They've always complained about prices, but this is different from historical grousing. This is a real-world, dollar-and-cents issue for them right now. They can't get customers in the door because of the prices.''

Sam Timmons of Fort Worth Tire, which sells used and new tires, says it's harder finding road-worthy tires for resale because they're being driven longer and come in bald.

"Because of money problems, people are running them until they're as slick as pavement," said Timmons, who laid off five employees in February 2009 and hasn't been able to replace them. "We spend $20,000 a year getting rid of the junk tires. We just get a trickle [of good used tires], and they're sold within days." [6]

However, the true significance of the Chinese tire affair - and even the jump in tire prices - is not the ancient story of the futility of protectionism. It's more about the consequences of globalization.

Tire-making is a globalized affair, driven by the needs of the globalized automotive industry. The automakers are world corporations pursuing world markets. GM sells more cars in China than it does in the United States. And global cars need tires from global suppliers.

When Chinese tires got squeezed out of the US market, they were replaced, of course, by other imports. But not necessarily imports by foreign brands. Many of the tires came from the global plants of the world majors, like Cooper Industries and a host of others.

South Korea's Hankook Tires - which has no US factories and has announced its strategy is to become the number one tire company in China - supplied 10 million tires to the US market in 2010. With a verbal awkwardness that is somewhat charming, it stated in its 2010 annual report:

Bridgestone Taiwan, which historically did not export, recorded a gratifying bump of one million tires in 2009.

Significantly, when the anti-PRC tire action was first mooted, neither one of the two nominally US tires suppliers, Goodyear and Cooper, supported the effort. True to their globalized priorities, they cared for the continued opportunity to maximize access to all markets for all their plants in every corner of the world.

Cooper is headquartered in Findlay, Ohio. It has plants in China that were a major source of low-end tires for the US market. When the protective tariff hit, it didn't start sourcing cheap aftermarket tires from its US plants to replace the Chinese supply. It shifted to its partners in Taiwan and South Korea to supply the US market.

Cooper, in fact, filed a statement with the US International Trade Commission opposing the protective tariff. In a public version made available by the website US China Law Blog, Cooper stated:

Cooper Tire has not abandoned the US tire market, and intends to continue some production in the United States. Cooper Tire invested in China because it could not compete on costs with lower-cost tires being imported by other US producers and importers from many different countries, not just China. Cooper Tire's customers were demanding lower-priced tires. The tires produced in China are made at a lower cost and allow Cooper Tire to even-out its overall production costs, compete for sales in the United States, and meet its customers demands. The reason the tires in China can be made at a lower costs is due to lower labor costs (including hourly rates and benefits), some (but not all) lower raw material; and much lower litigation costs (for not only product liability issues, but also US regulatory issues and other contractual disputes). [7]

The prime mover of the ruling was always the United Steel Workers union, which represents workers at 13 plants within the United States. In the end, the USW initiative arguably gained a few hundred jobs at the cost of tens of millions of dollars in increased tire costs for American consumers.

A certain amount of market inefficiency for the sake of increased employment is defensible. Or, alternately, the strategic and psychic satisfaction of poking a stick in the eye of the Communist Chinese dragon could be added to the rather short list of benefits of the tariff.

However, the most significant net effect of the tariff was to put more money in the pockets of Cooper and other globalized tire manufacturers. In the true spirit of globalization, these extra nickels did not necessarily trickle down to US workers.

Nor were these extra nickels denied to the PRC tire industry. Instead, it appears that the bulk of any tariff windfall will be invested overseas, in locations that not only provide cheaper labor costs - they offer faster growing markets.

Markets like China.

In August 2011, Tire Business magazine reported that global tire manufacturers had announced almost $10 billion in capacity expansions in the last 12 months:

Asia/Pacific accounts for nearly two-thirds of the budgeted investments, with Latin America getting $1.4 billion, or nearly 15%. Europe garnered a bit more than $1 billion and North America is getting $921 million, although Conti's greenfield plant project is not part of that figure.

Tire Business noted the following China projects:

· Bridgestone: $251 million to raise passenger tire capacity at two plants in China.

· Taiwan's Cheng Shin Rubber Co Ltd/Maxxis International: two new plants (their fifth and sixth plants in the PRC) at Xiamen and Chongqing, total investment of around $500 million.

· Goodyear: In the words of Tire Business, Goodyear "has begun trial production of passenger tires at its new Pulandian factory in Dalian, China - the company's first step toward replacing its existing factory in Dalian and doubling annual car tire capacity in China to more than 10 million units by 2015. The project is valued at $700 million over five years, about $200 million higher than previous disclosures."

· Hankook: $954 million through year-end 2015 for a car and truck tire plant in Liang Jiang Xin Qu, near Chongquing, China, capable of making 11.5 million car and medium truck/bus tires annually.

The US take, about $1.5 billion of the total, as opposed to about $5 billion going into China:

· Bridgestone: $125 million investment at its Aiken, SC plant.

· Michelin: $250 million for capacity increases at its Lexington, South Carolina and Woodburn, Indiana plants.

· CGS Holdings (Czech manufacturer of agricultural tires): $67 million for a plant in Iowa.

· Continental has announced plans for a major greenfield plant based in the USA "to serve the NAFTA [North American Free Trade Agreement] market" [ie Canada, the US and Mexico] with a possible budget of $500 million.

· South Korea's financially-strapped Kumho Tires has put its announced plant in Bibb County, Georgia on hold until at least 2013.

As for major US investments by the two US-headquartered majors:

· Goodyear: zero.

· Cooper: zero [8]

In its 2010 Annual Report, Goodyear cited "increased low-cost country sourcing" and "continued progress in actions to reduce ... high cost manufacturing capacity" as the cornerstones of its effort to dig itself out of its financial hole.

In a slideshow accompanying its 2011 second-quarter filing, Goodyear cited the "accelerated closure" of its Union City, South Carolina plant as an example of "Operational Excellence". As for "Enabling Investments": "First production of tires in new China factory" and "Expanding China retail network". [9]

Ouch!

Returning to the issue of the spike in tire prices in the US, the high protective tariff on Chinese tires was an enabling factor - but perhaps in a relatively unexpected way. It was not merely a matter of increasing the sales cost of the world's major low cost supplier so that other suppliers could compete in the "second- and third-tier" markets.

What appears to have happened instead was that the tariff to a large extent temporarily eliminated the low-end market, pushing consumers (at least those consumers who could afford it) toward the higher-end tires available from the global majors.

This shift exacerbated the supply problems in the United States in 2010 - when the tire industry was caught between its recession and restructuring - driven plant closings and the revival of the North American auto industry, thereby driving up prices.

The three-year window provided by the high Chinese tariff apparently did not lead to a fundamental restructuring of supply in the US low-end market, certainly not by US domestic producers; it simply temporarily tightened supply and gave tire companies a three-year opportunity to "make hay while the sun shone".

As for 2012, the year the tariff is supposed to go away, a China-tire hand wrote to Modern Tire Daily, the bible of the US tire salesman:

I have been dealing with China since middle 1998. At one point I worked for a major Chinese company for a year, and consulted with them after that. My China product sales at one point reached some 50,000 pieces a month. Immediately after the 35% duty add-on, it dropped to 2,000 to 3,000 pieces a month average: some months in a row zero, some months 4,000 to 5,000. Today, it barely averages 3,500.

Many (US) compan[ies] have swallowed the increases, as even with 35% on the top, they still need tires, and the US either does not make [them] or is still higher. But stay tuned for mid-2012. "My perception is that around April, at least in May and June, near 100% (of the US) companies will stop placing monthly production orders, waiting for the rest of the absurd, union-supporting, thanks-to-Obama duty to go away in September. The Chinese are very much a keep-the-factories-running country. No orders will not stop them from making tires. [It will] just stop tires from being shipped for two to three, maybe up to four months.

"And then the flood gates will open, and the world will see a price war like never before in history. Prices will drop like a lead balloon. [There] will be total chaos... [10]

Predictions of a tire Armageddon may be overstated. But it appears clear that the low-end tire market is still very much a Chinese affair. Global manufacturers manufacturing inside the United States did not discover a new-found love for making inexpensive, unbranded tires even when the duty is high, and relief for the consumer of cheap tires will appear only when the duty drops.

Under China's WTO Accession Protocol, other countries are only supposed to have a 12-year window for imposing protectionist duties. So one might expect that the United States will be looking at other ways to manage the China trade relationship.

However, 2012 is an election year, and a year in which the promise of jobs, any jobs, to reassure an American electorate afflicted with an official unemployment rate of over 9% may be welcome.

The US Trade Representative's office cited the creation of 3,000 jobs and $500 million in investment in the US tire industry since the tariff went into effect and welcomed reporters (perhaps rather half-heartedly) to connect the gains to the 421 tariff.

So don't expect protectionist sentiment to evaporate any time soon ... and don't be too surprised if the tire tariff is extended.

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